Lest shareholders of other food sector businesses get overly excited, Berkshire's proposed acquisition of Heinz at a 20% premium to market value does not appear to be juicing up other staid enterprises.
While equity investors at General Mills (GIS) did react favorably to the Heinz (HNZ) deal announcement, the reputational value metrics from Steel City Re reflect different outcomes to companies with similar stories but different antecedent metrics. The key indicator is current RVM volatility.

RVM, a non-financial indicator of reputational value, indicates among other things a company's sensitivity to macroeconomic uncertainty. The Current RVM Volatility for General Mills shows a modest correlation with the volatility of VIX, the Chicago Board of Option Exchanges S&P500 Futures Volatility Index or Fear Index. The Current RVM for Heinz does not. If one expects an economic downturn, Heinz is the safer place to be. And if one has a senior claim on cash flows, one is can be less sensitive to an equity price premium.

Early Thursday morning, The Wall Street Journal and the Pittsburgh Post Gazette, among many others, reported that H.J. Heinz Co. said it agreed to be acquired by Berkshire Hathaway Inc. and private-equity firm 3G Capital for more than $23 billion. Under the terms of the deal, which has been unanimously approved by Heinz's board, shareholders will receive $72.50 in cash for each share, a 20% premium to Wednesday's close. As expected, Heinz Chief Executive William Johnson affirmed, "The Heinz brand is one of the most respected brands in the global food industry and this historic transaction provides tremendous value to Heinz shareholders."

Deconstructing the deal from a reputational value perspective, Berkshire Hathaway is paying a 20% equity price premium to acquire a company with the highest reputational value premium in its sector, as shown in the reputational value metrics charts from Steel City Re. As discussed in Reputation, Stock Price, and You (Apress, 2012), the potential equity value implied by the reputational value premium was there for the taking; equity investors -- Warren Buffet, excluded -- just weren't seeing it. That value arbitrage, to give a name to Buffet's investment strategy, is what the RepuStars Algorithm attempts to expose through the RepuStars Variety Corporate Reputation Composite Equity Index (Ticker: REPUVAR).

Side Bar: Berkshire Hathaway and 3G Capital have pledged to maintain Pittsburgh as Heinz's global headquarters. The word "Variety" in the full name of the RepuStars Index comes from Heinz's tag line, 57 Varieties, for the reason that RepuStars comprises a portfolio of up to 57 names.
RepuStars Variety returns are reported each week on this blog. Steel City Re, which calculates the measures of reputational value and volatility, is also headquartered in Pittsburgh.

Returning to the measures, as of last Thursday when these were last calculated, Heinz's CRR, a measure of relative reputational ranking, was in the 96th percentile. Return on equity was in the 56th percentile, and RVM volatility, a non-financial measure of reputational value volatility, was in the lowest decile for most of the year spiking only recently to the 68th percentile. Return on equity has been keeping with the median for the sector. Last, prospects for future change, as reflected in the CRR vector and the related indication of stability at the 86th percentile, suggested little expectation of change. In other words, each of the various stakeholder groups, holding expectations appropriate to their experiences with the company, thought that they were valuing the company properly. Those views were not aligned -- but which group was off the mark?

Buffet's actions today, affirming the logic of RepuStars, suggest that equity investors were missing the boat.

The initiative will cover not just Unilever's greenhouse gas emissions, waste and water use – but the impact caused by its suppliers and consumers, from agricultural growers to the packaging and waste water produced by consumers of Unilever brands.
The Anglo-Dutch group also intends to improve the nutritional quality of its food products – with cuts in salt, saturated fats, sugar and calories – and link more than 500,000 smallholder farmers and small scale distributors in developing countries to its supply chain.

Looking at the reputation metrics, there is no indication that the market has been anticipating a major announcement of a strategic shift designed to increase enterprise value along with corporate reputation. Over the trailing twelve months, the Steel City Re Corporate Reputation Index rank has slipped progressively from the 58th percentile to the 34th percentile relative to the 25 peers in the Food: Major/Diversified sector. (The top ranked firms are currently HJ Heinz (NYSE:HNZ); Kellog Co. (NYSE:K) and TreeHouse Foods (NYSE:THS)). During this period, the company's return on equity has underperformed the median of its peer group by 2.75%. As of 11 November, the exponentially weighted moving average volatility of its Index ranking has dropped to 7.6%, but the Index velocity and vector are overall negative at -3% and -6% respectively.
The sector as a whole as shown a decrease in its median reputation ranking as well as a progressive decrease in the variance within the group. Last, the entire sector is heavily leveraged with the median intangible asset value fraction in excess of 100%. Unilver's intangible asset fraction of 118% is marginally greater than the median of 114%.
We'll be following Unilever to see how its sustainability strategy pans out.

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Although we intimated recently that new SEC regulations effective 28 February would drive risk and reputation management into the boardroom, we hardly expected 140 year-old Goldman Sachs (NYSE:GS) would be first at the wheel. Nevertheless, reading through this venerable investment bank's latest 10-K filing the next day, there it was--the first formal disclosure of headline risk.

We may be adversely affected by increased governmental and regulatory scrutiny or negative publicity. ...The financial crisis and the current political and public sentiment regarding financial institutions has resulted in a significant amount of adverse press coverage, as well as adverse statements or charges by regulators or elected officials. Press coverage and other public statements that assert some form of wrongdoing, regardless of the factual basis for the assertions being made, often results in some type of investigation by regulators, legislators and law enforcement officials or in lawsuits. Responding to these investigations and lawsuits, regardless of the ultimate outcome of the proceeding, is time consuming and expensive and can divert the time and effort of our senior management from our business ... Adverse publicity, governmental scrutiny and legal and enforcement proceedings can also have a negative impact on our reputation and on the morale and performance of our employees, which could adversely affect our businesses and results of operations.

Translating the above into lingua IAFS, Goldman Sachs is saying that their financial performance will be impacted adversely if their reputation is tarnished. They may lose pricing power, may have higher operating costs, may have higher credit costs, and may reward shareholders with lower equity returns.

As the Wall Street Journal reported the next day, March 2, this is the first known 10-K disclosure of "PR" risk. But it is hardly the first acknowledgement of reputation risk. For example, with respect to ‘PR risk,’ both German financial regulators and a 160 year-old Pittsburgh-based food company with a German-American heritage are well ahead of Goldman.

Last summer, the German financial regulator BaFin formally noted that reputation risk is a trigger of liquidity risk. Years earlier, the H.J. Heinz Company (NYSE:HNZ) created the first office of Risk and Reputation Management under the leadership of James Trout. Cutting to the chase, risk and reputation management is the new new thing. This Society is committed to ongoing thought leadership. Won't you join us?

And now, a tribute: Thank you, Dan Reynolds!

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If the above intrigues you, frightens you, or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials, including a new book, to further your executive career, and exciting monthly conferences such as the upcoming one on innovation.

Innovation: Hot Policy and Practice Issues

Be sure to register for a complimentary seat at the 5 March Mission:Intangible Monthly Briefing, held by phone at 12h00, EST. It's an innovation smack down. Athena Alliance President and intangible asset policy expert Kenan Jarboe goes head to head with Steel City Re's Judith Giordan, Managing Director of IA Finance and former senior technology executive with Pepsi, Henkel, International Flavors & Fragrances, and Polaroid. Yes, as always, registration is complimentary and slides are already posted on the website events page.

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Financial players are salivating over opportunities in the Food Products sector following Kraft Foods’ (NYSE:KFT) unsolicited $16 billion for Cadbury PLC (NYSE:CBY). According to Kraft’s CEO, Irene Rosenfeld, "We are eager to build upon Cadbury's iconic brands and strong British heritage through increased investment and innovation." Sounds to us like a reputation (brand) and intangible asset (innovation) opportunity.

So now that the sector is in play, we thought we’d look back over the past year and see how our predictions for value creation panned out. After all, when mergers and acquisitions are all the rage, if you are not at the table, you are on the menu.

Our last look at the Food Products sector was April 14 and was motivated by the sudden decline in the reputation standing of the HJ Heinz Company (NYSE:HNZ) as measured by the Steel City Re IA (Corporate Reputation) Index. The Index, which correlates with reputation surveys such as those published by Forbes, Fortune, and Harris Interactive, captures the financial implications of stakeholder behaviors and expectations of stakeholder behaviors as determined by corporate reputation. The Index is a good leading indicator of financial performance and returns on equity.

Six months ago, the top dozen ranked companies in the Food Products sector, according to the Index, included Heinz and Cadbury. Kraft was number 17. Here is our recap of the baker’s dozen with market value as of the close of the markets Friday 4 September before Kraft's announcement.

Heinz, a company that was highly ranked in March 2009 but caught our attention because of a sudden drop in its reputation standing, underperformed the balance of the baker's dozen over the full year with a disappointing -24.5% ROE. Kraft, which lost only 11% over the year, outperformed Cadbury which lost 16.5%. Firms that had a higher reputation ranking in March 09 slightly outperformed their peers. The correlation between rank and six month return was 16%. The top 12 firms, in a demonstration of reputation resilience, outperformed both the S&P Index and the Food Sector index with a loss, as a group, of less than 1%.

One other reputation note. Kellogg and Cadbury, both firms with strong reputation rankings and exceedingly strong brands, reported quality issues related to melamine and salmonella. We know that the impairment of reputation-linked assets such as quality have brought down companies from all sectors. We wonder, for the record, if business process challenges were responsible for making Cadbury an appealing target?

Note added after original posting:

Comments received after posting from readers of MISSION:INTANGIBLE focused on the relatively short window in which we reported economic results. The readers rightly pointed out that the Food Products sector is a long-term business. Tastes may evolve over time, but the business processes associated with delivering tens of millions of safe, quality meals reliably and repeatedly demand eternal vigilance. Consistency is the watchword, and therefore long-term financial results should be included in any discussion of reputation.

We agree. Below, the ten-year returns of the Baker’s Dozen listed above less Campbell’s soup (CPB) due to space limitations. Highest returns: JJSF; lowest returns shown KFT. The only major Food Products sector firm from our top 12 (sector rankings for reputation as of April, ’09) to underperform the S&P500 (10 yr equity return -20%) was CPB (not shown). Prices not adjusted for dividends.

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Tweens and adolescents often playfully disparage their meals with monikers such as "mystery meat" or "tuna surprise." While this is good fun, it is something quite different when the CEO of a major food products company similarly characterizes his company's products. David McKay of Kellogg Company (NYSE: K) raised a few eyebrows when he testified last month before the House Committeee on Energy and Commerce that Kellogg relied on third parties to assure food safety. We wonder what thoughts ran through the minds of financial analysts who knew at that time that competitors, such as Nestle, conducted their own supplier inspections thereby signalling to their stakeholders that food safety is a core business process and critical intangible/reputation asset.

And while it has been a rough time as of late with Salmonella in peanuts and pistachios, the industry as a whole is settling down to a steady state of intangible asset volatilty. So it piques our interest when H. J. Heinz Company (NYSE: HNZ), a company that has made reputation enhancement a key business strategy, experiences a sudden drop in the Steel City Re Intangible Asset Finance (Corporate Reputation) Index.

The chart below shows Heinz. As seen in the upper chart, among the 56 companies comprising the Food Products Group, Heinz has ranked in the top 95th percentile earlier this year but has been declining and is now at the 83rd percentile. In terms of return on equity, this past year it has outperformed the median of its peers by 2.6% - the peer group having lost a median of about 27% over the past 12 months. As seen in the lower chart, Heinz's exponentially weighted moving average IA index volatility began this last six month period at under two orders of magnitude and is now approaching three orders.

Yet while Heinz is showing a reputation decline and increasing volatilty, the industry as a whole is showing increasing stability. In the upper half of the chart below, the variance amond different companies in the peer group is leveling off at about 0.25. Furthermore, among all 5000 companies tracked by the IA index, the median IA index value of the peer group is rising to about the 72nd percentile. Last, the lower half of the chart below shows that the % of value at the Heinz Company ascribable to intangible assets has been increasing and now stands at about 120% while the median fraction in the peer group has been decling slightly to about 60%.

How is all this to be interpreted: decreasing IA index, increasing EMWA IA index volatilty, increasing IA fraction?

We believe its all about reputation. We believe that the extraordinarily high level of intangible asset value comprising some 120% of the company's market value (implying a negative book value) means stakeholders are relying greatly on extra-financial information to set a fair market price. Stakeholders are going with their gut, and gut is driven by reputation -- the impression stakeholders form on management's stewardship of a firm's intangible assets. The increasing volatilty associated with a decline in the IA index suggests to us that the impression stakeholders are receiving from these extra-fiancial channels is increasingly less uniform. Higher stock price volatility and increasing cost of both equity and debt will be among the earliest pains Heinz may experience.

Not convinced? Google search the stock ticker for Heinz, Kellogg, General Mills (NYSE:GIS), and Ralcorp (NYSE:RAH) - food product companies whose IA index values as of 6 April were .83, .90, .94 and .96 respectively - and the term "reputation." The hit counts are 504, 484, 543, and 1950. Did we mention that Ralcorp also had a peanut recall issue, yet their EWMA IA index volatility is decreasing and their ROE for the year is 23% above the peer-group median?